After a Big Drop, Is United Continental a Buy?

After a Big Drop, Is United Continental a Buy?

The troubles just keep coming at the world's largest airline. United Continental shares fell more than 9% on Friday, after the airline warned of a weak quarter. So what does United Continental look like going forward? We'll look at three key factors.

United Continental clearly laid out a top party to blame for its weak upcoming results. Yields -- or revenue per passenger mile -- were down in the Atlantic and Chinese markets. Let's look at each market separately.

On the Atlantic side, United blamed lower yields from shared tickets with its Atlantic partners. However, economic trends could be on United's side in this area over the next few years. A forecast from Ernst & Young calls for growth to return to the eurozone for 2014, rising to 1.5% annual GDP growth by 2015. Just as poor economic conditions hurt the demand for business and leisure travel, growing economic activity is a bullish sign.

In the Chinese market, United Continental blamed additional capacity for reduced yields. It's true that capacity is growing in the Chinese air travel market, but the market itself is expanding faster than those of developed nations. While we don't know for certain how Chinese carriers will react, we do know that capacity would have to continue growing fairly quickly to be a drag on the air travel market over the next few years. As we don't have all the information now, this is an area airline investors should keep an eye on.

Part of the benefit of being a large-scale operation is the ability to move workers from one position to another, and it's particularly important in the highly mobile airline industry. Since the merger, United Continental has had to put up with an inefficient labor setup, where only United pilots could fly United aircraft and only Continental pilots could fly Continental aircraft.

However, some progress is being made. About a month ago, United and Continental pilots merged their seniority lists in an effort that took into account various factors beyond just the hiring date. That move paves the way for United and Continental pilots to be able to fly the other airline's aircraft, dramatically increasing the efficiency of United Continental's labor setup. A few technical factors still have to be worked out, but the hardest part of labor integration appears to be finished.

And around a week ago, United Continental announced that it had reached a combined labor agreement with the International Association of Machinists, the union that covers the ground workers. With the unanimous support of the union negotiators, the plan will head for a vote that's expected to be completed by Nov. 1. This achievement adds to the airline's flexibility and should be seen as a positive development.

Other consolidations
The biggest news in the airline industry is the ongoing legal battle between prospective merger partners US Airways and AMR -- parent company of American Airlines -- and the Department of Justice, which has filed a lawsuit to block the merger.

The recent wave of consolidation has resulted in fewer airline price wars and the better management of airline capacity in the U.S. market. The merger of US Airways and AMR would represent the final chapter in airline megamergers, as it would create a market with three legacy/network carriers and Southwest Airlines as a point-to-point, primarily domestic carrier.

The benefits of such a merger would extend beyond the merger partners themselves, as it would allow carriers such as United Continental and Delta Air Lines to better manage prices and capacity. While it's not make-or-break for the airline industry, a successful completion of the US Airways/AMR merger would be a bullish sign for all major carriers.

Slowly progressing
The United Continental merger has been one of slow labor integration and technical glitches. But with labor issues being solved and the main technological integration complete, the airline has managed to put much of its troubles behind it. The latest report that sent shares down is definitely a negative, but Atlantic conditions should correct in the long term, while the expanding Chinese market still leaves a bit of uncertainty. In all, with possible further consolidation in the industry and most merger problems solved, United Continental is in the best place it's been since the merger. Investors bullish on the airline industry's prospects are urged to do further research on United Continental instead of avoiding it because of the share-price drop.

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Alexander MacLennan owns shares of AMR and Delta Air Lines and also has options on Delta and US Airways. This article is not an endorsement to buy or sell any security and does not constitute professional investment advice. Always do your own due diligence before buying or selling any security. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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